(Editor's note: This testimony was delivered by Fiscal Policy Director Michael D. LaFaive to the Joint Committee of Commerce and Labor, Appropriations Subcomittee on Commerce, Labor and Economic Growth on Oct. 14,2003.)

Good afternoon. First, let me say thank you for inviting me to testify today. I have been looking forward to an opportunity such as this for years. I am director of fiscal policy for the Mackinac Center for Public Policy where I have been employed for eight years. I handle economic-related policy issues for the Center, including the one I am most passionate about, and that is economic development.

My short remarks today will address basic economics and economic development issues; provide you with some anecdotal and empirical evidence on government’s inability to pick “winners and losers” in the marketplace; discuss the Michigan Economic Development Corp.’s role as a facilitator of state central planning, and explain why the Michigan Economic Growth Authority should be allowed to go gentle into that political goodnight — that is, why it should sunset. I have promised to do all of this in around 20 minutes, so I have to point out that, if you would like more details, you can easily find them on our economic development web module, which you can find at www.mackinac.org/ecodevo.

As the Center has written before, “economic growth refers to an increase in real output of goods and services per capita. Economic development describes a broader phenomenon of increasing standards of living and improved quality of life. Obviously, productive employment contributes to economic well-being and thus, fosters economic development. Economic growth, productive employment and economic development are the natural consequences of private enterprise in the free market economy. They are the product of free individuals and enterprises, acting to maximize their own self-interest and improved standards of living. It is not a product of intrusive governmental intervention or exotic policy schemes that give government officials the appearance of helping. The only way government can truly foster growth is to efficiently and effectively perform the unexciting and mundane task of ensuring the protection of private property and free exchange.

Since the Great Depression, when states began firing the first shots in the war over “jobs,” governments at all levels have been designing and using a wide array of incentive policies to encourage businesses to do one thing or another: move to a particular state, expand in a particular state, or give more training to workers, just to name three. Every state in the union maintains incentive programs, but economically speaking they are premised on two very fundamental flaws:

First, government has nothing to give anyone except what it first takes from someone else. If the MEDC takes tax dollars from a thousand businesses, and gives it to one, the one firm may have more resources to hire workers and create products, but the other thousand now have less. But this isn’t even a zero sum game. The money taken from others must be laundered through at least two expensive state bureaucracies (MEDC and Treasury) by way of state salaries that remove productive investment dollars from the economy.

Two examples come to mind. 1.Koegel Meats of Flint. In 1998 the MEDC’s predecessor agency (the Michigan Jobs Commission) offered a package to Boar’s Head Provision Company — a meat products company headquartered in Brooklyn, New York. In exchange for the company’s promise to invest $14 million and “create” 450 new jobs in Michigan Jobs Commission offered Boar’s Head an “economic development package” worth up to $5.1 million in federal, state and local resources. Armed with these “incentives,” the company opened a processing plant near Holland, Mich., on Dec. 13, 1999.

The MJC then added 450 new jobs to the rolls it could claim it was responsible for. But that’s only the benefit side of the equation. A portion of those incentives came directly from Michigan taxpayers, the Koegel family included. The Koegels own just one of Michigan’s meat processing companies (Kowalski is another) and have for almost 90 years. They have stayed in Flint through good times and bad and have never taken a dime of government money; yet they are now forced to compete against an out-of-state firm that their state has showered with economic favors. But it doesn’t end there. The bureaucrats who arranged these deals don’t work for free. Their salaries also remove money from the economy that might be best used by Michigan entrepreneurs if only they were allowed to keep it in the form of tax relief.

Another example the Mackinac Center has pointed to is Cabela’s Retail, Inc. In 1999, the MEDC informed Cabela’s that it would offer a package of incentives worth up to $27.8 million for locating a new, 200,000-square-foot store in Dundee, Mich. Cabela’s took the deal, and [then] Gov. John Engler hailed the deal as a win for Michigan, saying, “The additional tourists and 600 new jobs that Cabela’s will bring in to the state are welcome news.” But once again, proponents of this “economic development” strategy were only looking at the benefits. There is a cost side, too. First, Michigan tax dollars involved in the project, and second the harm it can do to the existing 1,000 Michigan sports retailers in the state, including the likes of Jay’s Sporting Goods. Jay’s Sporting Goods of Clare has been in Michigan since 1968 and has grown into a popular tourist destination of its own, and has done so without a dime of taxpayer money. The owner of Jay’s and widow of Jay Poet, the founder, was “flabbergasted” when she found out her state government was subsidizing her competition. “It makes you wonder who you’re working for,” she said.

There is an assumption that state bureaucrats, central planners if you will, know more about how to foster wealth and job creation better than business owners, consumers, workers, bankers, investors and managers, whose collective decisions form our market economy.

There is a substantial body of empirical evidence that shows organizations such as the MEDC, and the incentive programs they operate, are at best a zero-sum game. I would suggest that they’re probably a negative-sum game, especially if you consider the next best alternative foregone: cutting taxes and other business costs for all businesses, not just those lucky enough to win special favors from federal, state and local governments.

If state governments could really affect the economic well-being of job providers, employees, and taxpayers in general, we should be able to measure some type of statistically significant relationship between what a state spends on its economic development programs and a change in the Gross State Product of a state. Gross State Product is the value of all goods and services produced within the geographic area of a state. It is arguably the number one variable economists look at to gauge state’s overall economic well-being. The Mackinac Center has examined state spending on economic development programs in all 50 states and compared it to their respective per capita Gross State Products for several different time periods and found no significant correlation.

Consider a couple examples.

In 1996 Michigan ranked 9th — in the top 10 — in per-capita state spending on economic development programs. That same year, Michigan ranked 24th in per-capita GSP. By contrast, Texas was ranked 50th, or dead last, in per-capita economic development spending, yet outpaced Michigan with a ranking of 18th in per-capita GSP. If economic development programs were as valuable as proponents claim, they should correlate more strongly with higher GSP. In other words, Michigan should rank above Texas. Another example: In 2001, Michigan ranked 19th among the states in economic development expenditures and 30th in GSP. By contrast, California ranked last in economic development expenditures, yet beat Michigan by 22 spots, scoring a ranking of 8th in per-capita Gross State Product.

One program associated with the MEDC that deserves to be singled out for comment is the Michigan Economic Growth Authority, or MEGA. The MEGA is a 1995 creation of the Engler administration. It was sold to the Legislature and the public as a “jobs creation” program. The MEGA has the power to grant tax credits to companies that promise to create or retain X number of jobs in the state. The MEDC, working in concert with MEGA, often arranges for other incentives as part of MEGA deals. To date, the MEGA program has offered as much as $2.7 billion worth of incentives to fewer than 180 companies.

In 1999 and again in April 2002, the Mackinac Center examined MEGA job creation claims and found that the program had much to be desired. From April 1995 through December 2000, MEGA could claim credit for only 1.4 percent of all the jobs created in the state — and those numbers are probably inflated.

First, MEGA officials cannot prove that the companies involved would not have expanded or moved to Michigan without MEGA assistance. Nor can they prove that companies would not have “retained” their jobs in Michigan without special tax favors and other incentives. MEGA officials simply rely on the word of company executives in front of whom they have just dangled millions in financial incentives and expect them to be really, really honest. MEGA officials will counter that company representatives must sign an agreement stating that MEGA made the difference in their decision to start or expand a project in Michigan, but big deal. Among the first group of MEGA recipients was Waldenbooks. There executives it was later learned put deposits on homes in Washtenaw County before the MEGA law was ever passed. They were coming to Michigan anyway and just sought and received MEGA favors as the economic icing for their location cake. Waldenbooks did not have their deal withdrawn.

Second, MEGA officials cannot prove that these new jobs were not filled with people who were already gainfully employed elsewhere in Michigan and just shifted to firms receiving MEGA favors. When this happens the firm losing an employee to a MEGA company must then go out and find and train a new worker, at a considerable cost to themselves.

Third, job forecasts may be overstated. The economic analyses of MEGA’s impact on the Michigan economy is performed by University of Michigan economists under contract with the state. It appears as though these economists do not include important data (the costs and benefits of local property tax abatements, for instance) in their computer-generated models that would probably lower their estimate of real job creation in Michigan. Unfortunately, it is impossible to determine the degree to which such job creation claims are overstated because both the MEDC and the University of Michigan have refused to allow critical review of the forecasts.

Fourth, the opportunity cost of MEGA is not cutting taxes for all Michigan businesses, not just the favored few. Fewer than 180 companies have benefited from Single Business Tax relief offered through the MEGA program, yet there are more than 102,000 Michigan businesses that have SBT liability. Cutting taxes for all of these businesses would very likely create as many, if not more, jobs than has been credited to MEGA.

Fifth, MEGA is just unfair. Most of the firms chosen by the politically appointed MEGA board to receive tax credits have in-state competitors that do not receive tax credits or other special treatment.

MEGA and MEDC proponents have defended such programs from a variety of different angles, but the most repeated reason for maintaining these policies has been, “unilateral disarmament.” The idea then is that we must maintain an arsenal of tax and other incentive programs simply because other states do.

What departments such as the MEDC, and programs such as MEGA, are fighting over are job announcements, not real jobs. Economist Terry Buss reviewed hundreds of economic development studies involving state tax incentive programs. He concluded that studies were split on the issue of program effectiveness but most reported negative results. His review highlighted one 1996 study conducted by the state of Washington on its own tax incentive programs which reported that “there appears to be little correlation between the amount of tax benefit received by participants in the tax incentive programs and the growth in employment which resulted.”

Peter Fisher of the University of Iowa is an economic development expert and the co-author of the book, “Industrial Incentives: Competition Among American Cities and States.” When interviewed recently by The Detroit News he was asked point blank if Michigan could afford to “disarm” in these incentive wars that states have been fighting ferociously for 20 years. His response was the best I’ve heard yet. He said, “of course you can unilaterally disarm when you’re talking about an incentive — like the MEGA tax credit — that isn’t very effective anyway.”